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The Fed and Student Loans

progressivedem22
Posts: 1,304
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4/20/2014 8:41:56 AM
Posted: 2 years ago
So, not long ago Elizabeth Warren tried to fix the student loan interest rate at the discount window rate (.75%), which is the rate at which the Fed loans money over the short term to banks with liquidity problems, largely so they can meet their reserve requirements.

Obviously the Fed cannot directly inject money into the economy other than through making loans and purchasing bonds. But after they loan money to banks at such low interest rates, they loan it out to people at significantly higher rates.

So, how about cutting out the middle man? The Fed currently purchases $55 billion in mortgage-backed securities ($25 billion) and long-term treasury securities ($35 billion). What if it were to substitute some of its long-term asset purchases -- and, mind you, I'd love if it simply expanded the balance sheet to offset the taper -- by directly loaning to student at .75%? Student loan debt has peaked at $1.2 trillion, and without a doubt it poses a strain the broader economy.

Benefits:
-Helps to alleviate student-loan debt without relying on a do-nothing Congress

-Provides, if you take my suggestion and simply add this to the Fed balance sheet, additional monetary stimulus, expanding the "I" component of GDP and potentially eliminating, or at least mollifying, the zero-bound problem

-Provides opportunities to low-income households

-Interest rates are in the zero bound, so inflation is improbably, if not impossible, so "printing" doesn't actually cost anyone a dime.

-If this were to, on an off-chance, spur higher inflation, that would only reduce real nominally-denominated debt burdens, which is not only good for students, but good for the broader -- particularly financial -- economy at a time of constant deleveraging

-State budgets for education have been cut brutally, so the increase in demand for college education will provide a significant boon to state governments

Cons:

-Expanding the Fed balance sheet usually isn't seen as politically popular.

-Gold Bugs will complain about the apparition of inflation, not realizing that the PCE deflator has been flat vis-a-vis a tripling of M2.

-We would have to hash out how exactly interest rates would rise, for if the economy recovers, the discount window rate will return to normal -- above 5% -- though that will still be less than private lending institutions. So, does that put private institutions out of business, or simply apply downward pressure on interest rates?
Khaos_Mage
Posts: 23,214
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4/22/2014 8:33:24 PM
Posted: 2 years ago
At 4/20/2014 8:41:56 AM, progressivedem22 wrote:
What are the frequency these loans are paid back?
Is it not a huge liability?
If the loan isn't paid back, isn't that inflation, then?
My work here is, finally, done.
progressivedem22
Posts: 1,304
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4/23/2014 7:25:02 AM
Posted: 2 years ago
At 4/22/2014 8:33:24 PM, Khaos_Mage wrote:
At 4/20/2014 8:41:56 AM, progressivedem22 wrote:
What are the frequency these loans are paid back?
Is it not a huge liability?
If the loan isn't paid back, isn't that inflation, then?

To my knowledge, yes, they are very low-risk loans.

I wouldn't say that's inflation if they're not paid back. If anything, it could add to excessive reserves, which somewhere down the road could translate into inflation, sure, but with such a low velocity right now I don't think that's much of an issue. And, as I said, I think a higher inflation target is a fundamentally good idea right now.
slo1
Posts: 4,333
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4/24/2014 7:50:30 AM
Posted: 2 years ago
The fundamental problem is this:

Interest rates are in the zero bound, so inflation is improbably, if not impossible, so "printing" doesn't actually cost anyone a dime.

The Fed can not indefinitely expand it's balance sheet. Everytime it buys treasuries or mortgage security it is putting money in the economy via the banks that loan it out. The reason we have not see inflation yet, despite there $4 trillion balance sheet is that we have yet to turn the corner on looser lending standards, which increases velocity and thus demand for good and services thus inflation.

Inflation will come. With that said, is there a fundamental difference betweem buying mortgage securities versus student loan debt?

The main difference is when they need to unwind their balance sheet and take money out of the economy. In other terms when they sell the debt back to private hands.

As an investor you more likely to buy something earning 4% interest or .75% interest? If you choose .75% instrument you are getting it at a huge discount.

Either way, both are ultimately subsidies that the public has to pay via inflation at some point.
progressivedem22
Posts: 1,304
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4/24/2014 11:13:18 AM
Posted: 2 years ago
At 4/24/2014 7:50:30 AM, slo1 wrote:
The fundamental problem is this:

Interest rates are in the zero bound, so inflation is improbably, if not impossible, so "printing" doesn't actually cost anyone a dime.

The Fed can not indefinitely expand it's balance sheet. Everytime it buys treasuries or mortgage security it is putting money in the economy via the banks that loan it out. The reason we have not see inflation yet, despite there $4 trillion balance sheet is that we have yet to turn the corner on looser lending standards, which increases velocity and thus demand for good and services thus inflation.

I agree with you that the Fed can't expand its balance sheet forever, and you're quite right that it is effectively putting money into the economy that could be injected into the economy from excessive reserves and lead to run-a-way inflation down the road. My only point is that I don't see this as likely, at least right now, and even if it were to happen, the Fed could simply raise interest rates in a matter of minutes and effectively nullify the problem, anyway -- and I wouldn't see much harm in a 4% target.

I also disagree with you that the Fed has yet to turn a corner. It went from buying $85 billion per month last December -- when it did have a $4 trillion balance sheet, mind you -- to buying $55 billion per month now after three consecutive mini-tapers, so that translates into, ceteris paribus and assuming no further tapers, a $360 billion effective taper vis-a-vis its typical asset purchases, or a balance sheet of 3.64 trillion if my math is right. I'm not saying that's not large, necessarily, but I think a lot of the rhetoric from Janet Yellen has been very mixed: the whole "6 months" thing then "there still slack in the labor market and we have a long term committment.." so it's hard to predict what she's going to do next, though I think we would both agree that short-term rates are staying at 0, at least in the near term, so barring so random recovery, inflation will stay fairly low.

Inflation will come. With that said, is there a fundamental difference betweem buying mortgage securities versus student loan debt?

The main difference is when they need to unwind their balance sheet and take money out of the economy. In other terms when they sell the debt back to private hands.

As an investor you more likely to buy something earning 4% interest or .75% interest? If you choose .75% instrument you are getting it at a huge discount.

So your argument, if I'm understanding you correctly, is that student loans, down the road, because their interest rates are fixed -- and allowing them to adjust, at least I think, would be a complete disaster -- and would be fixed at 75 basis points, they would be a horrible investment. Is that correct?

It's a good point, and does speak to the significant disparity in the relative risk of the investments. But I'm almost tempted to think that this isn't relative in light of the benefits: for instance, the federal government profited to the tune of over $100 billion on student loans. I think that's honestly inconceivable, but I think it also shows us that higher education is a public good, and if we can invest in that in a way that dodges Congressional gridlock all together, I tend to think that we're all better off.

Either way, both are ultimately subsidies that the public has to pay via inflation at some point.

At some point, sure, but again, I don't think this has much bearing amid the zero bound.
slo1
Posts: 4,333
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4/24/2014 1:36:31 PM
Posted: 2 years ago
At 4/24/2014 11:13:18 AM, progressivedem22 wrote:
At 4/24/2014 7:50:30 AM, slo1 wrote:


As an investor you more likely to buy something earning 4% interest or .75% interest? If you choose .75% instrument you are getting it at a huge discount.

So your argument, if I'm understanding you correctly, is that student loans, down the road, because their interest rates are fixed -- and allowing them to adjust, at least I think, would be a complete disaster -- and would be fixed at 75 basis points, they would be a horrible investment. Is that correct?

This is where I get a little foggy with Fed activities. They can either hold onto the treasuries, mortgage securities, or student loans (if they were to buy them) until they are due. However that is long term debt is is not entirely likely they will hold on to them that long.

If they sell them back to private parties to take money out of the system, they do so in a time of higher interest rates and since these are low interest investments they loose value. In other words that $4 trillion of investments will not fetch $4 trillion back if they sold them during period of higher interest rates. Where I am foggy is whether that even matters to the Fed because they don't need cash to buy the investment instruments to begin with.

It's a good point, and does speak to the significant disparity in the relative risk of the investments. But I'm almost tempted to think that this isn't relative in light of the benefits: for instance, the federal government profited to the tune of over $100 billion on student loans. I think that's honestly inconceivable, but I think it also shows us that higher education is a public good, and if we can invest in that in a way that dodges Congressional gridlock all together, I tend to think that we're all better off.


I would agree and I would even classify that higher education is a greater public good than subsidizing home ownership. It is the old adage that you can give the guy a fish or teach him how to fish.

Either way, both are ultimately subsidies that the public has to pay via inflation at some point.

At some point, sure, but again, I don't think this has much bearing amid the zero bound.